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Country Commercial Guides for FY 2000: Poland Report prepared by U.S. Embassy Warsaw, released July 1999 Note*

CHAPTER II: Economic Trends and Outlook

A. Major Trends and Outlook

Poland has been making steady progress in raising its living standard closer to those in the European Union (EU). Per capita income in Poland (on a purchasing power parity basis) has risen from 31 percent of the average level in the EU in 1993 to 39 percent in 1998. Nonetheless, it will take decades more for Poland to reach the EU average. A dynamic private sector and sound fiscal and monetary policies have produced one of the fastest growing economies in Europe since 1994. The large, inefficient agricultural sector (which employs as much as a quarter of the workforce) and numerous loss-making state-owned enterprises have lagged behind the rapidly developing private sector. Both the unemployment rate and the inflation rate have been declining from very high levels in the early 1990's.

A two-party coalition with roots in the Solidarity movement of the 1980's came to power after in the 1997 parliamentary elections. The senior coalition partner, Solidarity Electoral Action (AWS), and the junior partner, the Freedom Union (UW), both support free market economic principles, and they advocate acceleration of economic reforms and privatization. All of Poland's post-1989 governments (from across the political spectrum) have pursued economic reforms and generally sound fiscal and debt policies. Poland continues to liberalize its trade, foreign exchange, and investment policies in accordance with its international obligations to the World Trade Organization (WTO), the European Union (EU) (as contained in its Europe Agreement), the Organization for Economic Cooperation and Development (OECD), and its neighbors pursuant to numerous trade and economic relations agreements.

The economic slowdown in Europe, the crisis in Russia and conscious economic policy decisions at home have contributed to a cooling off of the Polish economy. From 1994 to 1997, the economy expanded by over five percent per year in real terms. In 1998, the growth rate slipped to 4.8 percent, and in the first quarter of 1999, it expanded at the annualized rate of 1.5 percent. The economy started to bounce back after the first quarter and is expected to show growth of 3.5 to 4.0 percent for 1999. The recovery should continue into 2000. The Finance Ministry assumes real growth of 5.6 percent for 2000 in its budget proposal. In dollar terms, Poland's GDP in 1998 equaled USD 158 billion, or USD 4,070 per capita. On a purchasing power parity basis, per capita income in Poland rose from USD 7,600 in 1997 to USD 7,900 in 1998. The private sector accounts for an estimated 70 percent of GDP (including a large gray market), and almost 70 percent of the labor force. The official unemployment rate edged down from 13.2 percent at the end of 1996 to 10.4 percent at the end of 1998, and it has bounced up over eleven percent in the first half of 1999. A substantial proportion of this increase was due to a new health reform requirement that non-working individuals not actively seeking jobs register as unemployed in order to receive health benefits. The rate of inflation in consumer prices (on a December-to-December basis) declined to 8.6 percent in 1998 from 18.5 percent in 1996, and it is expected to be lower than seven percent for 1999.

In 1998, Poland formally initiated accession negotiations with the EU, which should lead to membership after 2002. Polish monetary authorities expect that within a reasonable period of time after joining the EU, Poland will qualify for the European Monetary Union (EMU) and replace the Polish zloty with the Euro. The fiscal and monetary authorities face major economic challenges in the mid- to long-term. These challenges include completing the privatization and restructuring process, rationalizing and reforming the agriculture sector, bringing the inflation rate down to a level comparable with EU average, financing infrastructure and human capital development, and reducing the public sector budget deficit. Moreover, Polish leaders have initiated a debate over what role the state sector should play in the economy. In particular, the coalition partners are considering whether to lower taxes in order to force the state sector to shrink. For its part, the private sector will need to improve its competitiveness so that it can hold its own domestically and expand exports. How Poland deals with these issues will have a great impact on its rate of convergence with the EU's average living standard, whether it will take a couple of decades or much longer.

B. Principal Growth Sectors

Growth was uneven in 1998, with some sectors doing fine and others in dire straits. The construction industry, automobile industry and service sector continued to do well despite the slowdown throughout much of the rest of the economy. The agriculture, textile, electronics, and furniture sectors suffered greatly from the collapse of the Russian market and stiffer competition from Asian firms. Heavy industry and coal mining remained in the doldrums. In 1998, foreign and domestic investment, credit expansion, and wage increases bolstered domestic demand and generally cushioned the economy from external shocks. Polish exports stagnated in 1998 and early 1999. The depreciation of the Polish zloty in 1999 against the U.S. dollar and, to a lesser extent, the Euro should spur export growth.

C. Government Role in the Economy

The progress of Polish economic recovery has occurred in large part due to the sound monetary and fiscal policies maintained by a succession of governments since 1989. The central government budget deficit was 2.4 percent of GDP in 1998 and the government expects to meet the 1999 budget deficit target of 2.15 percent. For the year 2000, the Finance Ministry is drafting a budget proposal to reduce further the budget deficit to 1.8 percent of GDP. The Finance Ministry has set a goal of balancing the central government budget by the year 2003.

Taxes in Poland are relatively high: VAT rates are zero, seven, and 22 percent; the corporate income tax is 36 percent; personal income tax brackets are 20, 32, and 44 percent. Social program contributions for pensions, disability and unemployment benefits, and health care amount to 48 percent of net wages in aggregate; the employer and the employee each pays a portions these contributions. In 1999, the government plans to finance the budget deficit principally from domestic borrowing and privatization revenues. The constitution prohibits the government from borrowing from the NBP.

Poland has privatized practically all small enterprises, most medium-size enterprises, and is now concentrating on the large enterprises. The government has set itself the goal of privatizing 70 percent of the remaining firms by the end of its four-year term in 2001. The government in the first half of 1999 has already privatized two large banks and later in the year should sell strategic stakes in the telephone company (TPSA), the national airline (LOT), the dominant insurance company (PZU), and several firms in the steel and energy sector. After these privatizations, the share of GDP generated by the private sector should increase from around 70 percent to 85 percent.

D. Balance of Payments Situation

Since 1995, Poland has run a steadily rising current account deficit: 1.0 percent of GDP in 1996, 3.2 percent in 1997, 4.3 percent in 1998, and an estimated 5.5-6.0 percent in 1999. The government expects the current account deficit as a percentage of GDP to start to decline in 2000. Foreign direct investment (FDI) inflows cover most of the current account deficit. Poland has attracted about USD 30 billion of FDI since 1990, according to the Polish Agency for Foreign Investment (PAIZ). PAIZ estimates that FDI inflows for 1999 will reach USD 10 billion. In the first five months of 1999, Poland ran a current account deficit of USD 3.8 billion, of which FDI alone covered USD 1.9 billion. Large capital surpluses due to FDI and portfolio inflows have caused net official reserves to pile up this year, from USD 21.2 billion at the end of 1997 to USD 26.1 billion at the end of May 1999. Short-term or portfolio investment finances only a small portion of the current account deficit.

The current account deficit derives from Poland's trade deficit: USD 13.7 billion in 1998 and USD 4.8 billion through the first five months of 1999. Poland's surplus in unregistered or so-called "suitcase" trade, which shows up in the Unclassified Transactions item of the current account, has declined significantly in 1999: from USD 2.3 billion for the first five months of 1998 to USD 1.3 billion for the same period in 1999. This decline reflects in large part the drop off in exports to Russia and Ukraine. Analysts predict that the depreciation of the Polish zloty in 1999 (down about 15 percent in value against the U.S. dollar and six percent against the Euro) should give a boost to Polish exports.

Poland greatly benefits from the 1991 Paris Club and the 1994 London Club debt-rescheduling agreements, which roughly cut in half Poland's foreign debt. In 1995, Poland paid back all IMF drawings.

E. Infrastructure Situation: Distribution

Communications, banking, insurance, accounting, and distribution systems are still developing in Poland. Companies establishing branch offices find office space and housing in short supply and very expensive -- class A office space rents are similar to those in Geneva. Foreign companies can acquire small parcels of land without obtaining government permission, but the government has moved slowly in granting permits to acquire large parcels and some companies have complained there still are unnecessary delays in acquiring small parcels. There is a shortage of personnel with training and experience in some fields, particularly in finance, marketing, and human resources.

After the privatization of two large banks in 1999, foreigners control nearly 60 percent of the banking sector's equity and a majority of its assets and deposits. Banks are well regulated by the NBP. They now set their own lending and deposit rates. Interest rates are relatively high (around 20 percent), but should come down with the expected decline in the inflation rate and the NBP's planned reduction of mandatory reserve levels.

The road system is inadequate for the increasing number of cars and trucks. The number of cars in Poland exceeds twelve million in 1999, more than double the number in 1990. There is especially a lack of adequate (four-lane) highways between major cities capable of carrying the increased volume of trucks necessary to the growth of Poland's distribution systems. An extensive road network upgrade is planned over the next 10-15 years, but much of this is not even in the design phase. Rural road travel is particularly difficult and very dangerous at night. Poland's air and seaports are structurally adequate for receiving and shipping cargo. However, all are in need of expansion and modernization to facilitate the growth of Poland's economy. Airport cargo modernization is underway. A restructuring of the rail system is under examination. The existing rail network in Poland is relatively extensive.